A Critical Analysis of the Downfall of Lehman Brothers Holdings Inc.

This essay provides a comprehensive analysis of the downfall of Lehman Brothers, one of the largest investment banks in the United States. It begins by outlining the company's history and its position in the financial market before its collapse in 2008. The essay delves into the key factors that contributed to the bankruptcy, including the company's excessive leverage, particularly its investments in mortgage-backed securities, and the subsequent subprime mortgage crisis. It examines the role of the company's compensation system, which incentivized risk-taking, and the lack of buyers when the company faced financial difficulties. Furthermore, the essay discusses the impact of the Federal Reserve's decision not to provide an emergency loan and the repercussions of the bankruptcy on the global financial system. The analysis draws on various sources to provide a critical and in-depth understanding of the events leading to the collapse, offering insights into the mismanagement and systemic risks that ultimately brought down Lehman Brothers and triggered the global financial crisis.

Running head: THE DOWNFALL OF LEHMAN BROTHERS
The downfall of Lehman Brothers
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Lehman Brothers Holdings Inc. was one of the largest investment banks in the Unites
States of America, up to the year 2008. The company, a global provider of financial services,
was only behind Goldman Sachs, Merrill Lynch and Morgan Stanley, as far as the competition in
the Wall Street was concerned. The company was founded in the year 1850 in Alabama and had
its headquarters in New York City, United States. The company provided various financial
services worldwide, which included fixed income sales, trading, investment banking, equity,
private banking and so on. On 15th September, 2008, the company filed for bankruptcy (ABC
News 2018). The company had been in operations for approximately 158 years when it became
defunct in 2008 itself. The company had filed under Chapter 11 Bankruptcy Protection, owing to
the exodus of all its clients, the disastrous crash in the stock market and devaluation of all its
assets by the credit rating companies (Wolff 2018). The company’s mortgage crisis is considered
to be primarily responsible for the fall of the Lehman dynasty. This massive scandal was one of
the largest of its kind and this can also be said to be the beginning of the global financial crisis
that plagued the world in the 2000s (Fleming and Sarkar 2014). The question arises as to what
or who was actually responsible for the downfall of the Lehman Brothers. The following
essay takes a critical and analytical look at the Lehman Brothers controversy.
The Lehman Brothers, before its fall, had been one of the strongest and most powerful
names, not just on Wall Street, but also across the globe. As the economy of the United States
grew over the decades since its establishment, the company prospered and continued to grow for
a period of nearly 150 years. It would not be an understatement to call the company an
international powerhouse. Yet, this is not to say that the company did not face severe
challenges over the years. However, the company managed to stand tall amidst several odds
which included the railroad bankruptcy in the 1800s, two World Wars, the Great Depression in

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the 1930s, the capital shortage by American Express Co. in 1994, the Russian Debt Default of
1998s and the Long Term Capital Management collapse. Despite having survived all these
obstacles and potential dealbreakers, the company finally succumbed to the fall of the housing
market in the United States, which proved to the disastrous for the company. It is thus important
to study, what exactly went wrong at the Lehman Brothers (International Business Times
2018).
In the years 2003 – 2004, the United States housing market was expanding at a rapid rate
and was expected to grow steadily for the next few years. Sensing an opportunity for good
investment, the Lehman Brothers acquired around five mortgages, which included the subprime
lender BNC mortgage and also the Aurora Loan Services. The investment seemed quite
sound and fail proof at the time. The real estate business of the company experienced a surge of
nearly 56 % between the years 2004 and 2006 (Lioudis 2018). This rate was quite impressive
and assuring, as compared to that of any other company in asset management and investment
banking. In the year, the company secured mortgages worth 146 billion US dollars, which was a
10 per cent increase from the year 2005. Until the year 2007, the company registered high
profits and had a net income of approximately 4.2 billion dollars and revenues worth 193 billion
dollars. In 2007 in February, the stocks had reached nearly 86 dollars, which endowed the
company with a market capitalization worth 60 billion dollars. However, by the middle of 2007,
the foundations of the US housing market was beginning to shift and cracks were
beginning to appear (Wiggins, Piontek and Metrick 2014). In March of 2007, the stock market
witnessed one of the biggest drops in the last five years, which is expected to have had an impact
on the profitability of Lehman Brothers. The management of the company claimed that despite

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the sudden shifts in the stock market, the delinquencies had been taken care of and no impact
would be felt on the earnings of the firm.
This was the beginning of the end for Lehman Brothers. The credit crisis began in
2007 and resulted in the failure of a number of hedge funds. At this time, the stock market for the
Lehman Brothers crashed. Additionally, the company was forced to shut down the BNC
mortgage unit and also terminate nearly 2500 employees who were employed in the mortgage
related jobs. However, at this point, the company had managed to retain its position as a top
player as far as the mortgage market was concerned (Dumontax and Pop 2013). By the end of
2007, the company had almost recovered from the initial shock and was beginning to regain its
footing. It can be argued that the company’s high leverage degrees were predominantly
responsible for the company’s ultimate failure. In the year 2007, the ratio of the assets of the
company to the shareholders’ equity was 31. Moreover, the number of mortgage securities which
had been exposed during the previous quarters of the fiscal year rendered the company
vulnerable to the rapidly deteriorating conditions of the market. By March 2008, the market
shares of the Lehman Brothers had fallen by almost 48 per cent. At this point, it could be
predicted that the next firm on Wall Street to fall would be Lehman Brothers. Despite the
numerous hurdles, the company managed to keep standing and even improved its positioning in
April by raising nearly 4 billion dollars in profits (Del Giovane, Nobili and Signoretti 2013).
Nevertheless, the value of their sticks began to decline rapidly since the managers in charge of
hedge funds were now beginning to question the valuation of the Lehman Brothers’ mortgage
portfolio.
Throughout 2008, the company attempted to fight off losses and devaluation by selling its
assets, issuing stick and also reducing costs. There were massive subprime or low rated

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mortgage loans which the company found nearly impossible to pay off. When these loans
were rendered illiquid, the company had lost its ability to pay the creditors back. At one point,
the company was stuck in a rut and could not issue stock nor raise cash through credit. In other
words, the company was descending into a quicksand of debt, which was impossible to recover
from. Meanwhile, the housing prices were beginning to fall, owing to the declining market
conditions and the tendency of the home buyers to remain on the safe side. However, no measure
could suffice or make up for the damage that had already been done. The stocks had plunged to a
miserable 77 per cent by September 2008, while the equity markets around the world were
plummeting. By this time, the CEO, Richard Fuld’s plans to keep the company independent were
also beginning to fall apart. Around this time, the company incurred losses amounting to almost
4 billion dollars. In order to counter it, the company attempted to completely revamp and
restructure its organization. However, such measures proved to be feeble attempts to recover. By
the end of the first week of September, the once magnanimous Lehman Brothers had only about
one billion dollars left in cash in its savings.
It must be remembered that the Lehman Brothers was one of the largest financial
companies in the world, and such deplorable conditions within the company were beginning to
affect the overall financial system across the globe. As a result, liquidation of the firm
remained the only possibility. In September of 2008, the Federal Reserve Bank of New York
met to discuss the future of the investment banks of the United States. The meeting concluded
with the decision to liquefy the bank assets since that would help in stabilizing the markets.
Finally, on 15th September, the company was declared bankrupt (Ball 2016). The repercussions
were felt in the United States and across the world. For instance, on the same day, the stocks of
the Daw Jones fell by nearly 500 points (Leaven and Valencia 2013).

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There are a few things which went wrong at the company, which caused it to hurtle
towards its downfall (Harvard Business Review 2018). One factor was excess leverage. The
main concept related to financial leverage involves taking a loan and investing of that money in
order to attain higher rates of returns. Usually, investment banks borrow money in the form of
loans or deposits and then pay a fixed rate of interest on the money borrowed. This money is
then invested in order to get better returns on it. However, in the case of Lehman Brothers, the
company was overleveraged. The company had taken huge loans in order to invest them in
MBSs or Mortgage Backed Securities. However, it turned out that the mortgage backed
securities were worth much less than it was actually perceived. The debt to equity ratios of the
company was risky, which led to its failure (Fernandez and Wigger 2016). The debt to equity
ratio of the company would determine the amount of debt a company has for every dollar in the
equity. Investment banks like Lehman Banks usually have high ratios. For instance, the debt to
equity ratio for the Lehman Brothers was often 30 – 60 to 1. However, the sudden drop in the
value of the assets led to a shift in the ratio which eventually led to bankruptcy.
Another major factor that was responsible for the downfall of the Lehman Brothers was
the compensation or bonus system that had been implemented. The system provided
compensations to the people for having generated stellar returns. In other words, the company
paid a bonus when the firm managed to perform well. Yet, when the employees failed to perform
well, they were not penalized or punished for the same. Since the employees literally had nothing
to lose, they were not motivated or committed to their work. The lack of buyers was another
major factor in this case (Prestley and Jones 2014). In the cases of Washington Mutual,
Wachovia or even Bear Stearns, the lack of buyers and customers was responsible for troubles
and crises. Yet, these companies managed to garner support and acquired more buyers, whereas

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Lehman did not (Kensil and Margraf 2015). When it comes to Lehman Brothers, the Bank of
America had been interested but they preferred to go with Merrill Lynch instead. In short, no
firm had the prime motive to save the company and were more focused on their own profits.
Acquisition had been the only remaining alternative to liquefaction; yet, the lack of interested
buyers proved to be detrimental for the company. The balance sheet of the company was a
disaster in disguise. Due to a lack of interested buyers, the Federal Reserve Bank of New York
decided to provide the bank with an emergency loan but backed out last minute due to the poor
balance sheet. The company was declared incapable of having enough collateral for back up
(Duygan Bump et al. 2013). The Federal Reserve could easily have provided an emergency
loan, yet it chose not to. This is because it was assumed that the bank would sustain a major loss
when the bank would eventually collapse in the long run (Stewart and Eavis 2014). Moreover,
the general public would not accept the move on the part of the Federal Bank to help Lehman
Brothers. The customers and citizens of the United States were getting quite impatient with the
overall financial industry. If the Federal Reserve stepped in to help such a bank, it would have a
negative impact. In short, the collateral at stake was too much, which led to the Federal Reserve
to allow the bank to fail (Mensah 2015).
According to certain critics, it was the supreme rule of Fuld which led the bank to its
downfall. The bank was completely under the monopoly of Fuld for more than 18 years. A book
published by a previous employee of the bank revealed that Fuld was extremely insecure about
his position and was intolerant towards individuals below him who were more talented than him.
According to accounts of the ex employees of the company, Fuld wanted to be the emperor of
the company and followed a bureaucratic leadership style which ended up costing him the
company (Stein 2013). Also, it can be said that the board members were backdated and belonged

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to a different generation. Most of the board members of the bank were above the age of 70,
which meant that they belonged to a different period in finances altogether. These board
members were not receptive to the new changes and trends in the banking industry and watched
silently, as the dynasty came crashing down (Stevens and Buechler 2013). In retrospect, it can be
asserted that the fall of Lehman Brothers was not simply due to deteriorating financial
conditions, but also due to political factors. As mentioned above, it was politics which
determined whom to save and whom to fail during the Lehman fiasco. For instance, the Federal
Reserve attempted to save institutions which would be systematically important in the long run,
and unfortunately, Lehman Brothers did not fall under this category (Cline and Gagnon 2013).
It must be ascertained that there was no one single cause that led to the failure of the
Lehman Brothers. For a firm founded in 1850 to collapse all of a sudden in 2008, there must
have been several triggers and forces which resulted in the downfall. Following the scandal,
reports were published in the year 2010 which detailed every minute aspect of the business and
scrutinized all the myriad activities of the executives. It was around this time that the executives
were blamed for gross negligence and even unethical practices (Stevens and Buechler 2013).
In fact, a large number of executives of the company were misusing their position in order to
acquire short term gains which proved to be detrimental for the company. The extreme greed of
the traders on Wall Street, the actions of the Federal Reserve, the credit rating agencies, the
mounting debts of the American households and deregulation were just some of the things that
went wrong at the bank. Out of these, the credit default swaps or the subprime mortgage
loans were the biggest factors which led to the ultimate catastrophe (Kim, Koo and Park
2013). The subprime crisis of the year 2007, as it is now known, was what snowballed into a
larger disaster in 2008. The subprime crisis initially began in the financial spheres of America,

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but eventually spread like a virus to the non – financial institutions as well. Eventually, this had a
sort of chain reaction in the market. With its massive investments in the market, the Lehman
Brothers had caused erosion in the subprime US housing market, which was looked down upon
by both the Federal Reserve and the other investment banks. The US government did take
measures to counter the disaster and the attention was slowly shifting towards one particular
organization that was deemed to be partially responsible for the fiasco. This is also probably why
the Federal Reserve refused to come to the rescue of the bank in 2008.
Prior to its downfall, the Lehman Brothers was running on negative cash flows. As a
result, the company was neither able to pay back its loans nor was it able to live up to its
obligations. The company was also unable to maintain a level of confidence, which was triggered
by business and market conditions. This is because the market at present was concentrated and
saturated with illiquid assets which were declining in terms of value. In order to push this factor
under the rugs, the accountants and executives at the company deliberately came up with
carefully manipulated statements which showed otherwise. Moreover, the Lehman Brothers had
been using the Repo 105, which is a kind of repurchase agreement that aids organizations in
manipulating financial statements (Jones and Prestley 2013). However, this was done secretly
and the company had failed to mention that to its own board of directors, let alone the investors,
the rating agencies, the government or even the Federal Reserve. Yet, the auditors were perfectly
aware of the situation and the consequences of such an act (Wiggins, Bennett and Metrick 2014).
Despite the disaster that was Lehman Brothers, there are some lessons to be learnt from
the fiasco (Srivastava 2018). For instance, investors need to seriously take into account the price
paid for stocks. It was the global financial crisis and ensuing panic which caused the stocks to
plummet in the year 2008. Yet, if Lehman Brothers had not used Repo 105, they would have

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been able to avoid such a scene. While the Repo 105 is not illegal, it violated the Sarbanes
Oxley Act of 2002, because the financial statements which had been manipulated were
misleading and did not reveal the actual status of the company (Wiggins and Metrick 2014). As a
result, the company ended up losing the goodwill of the investors. Secondly, it is extremely
important for a financial organization to have a well defined structure within the company. After
the company declared bankruptcy, the extremely intricate and complex structure of the
organization was blamed (Gambacorta and Mistrulli 2014). By 2008, the Lehman Brothers
were conducting operations across the globe and had more than three thousand legal entities. All
of these made the organizational structure extremely complicated. As a matter of fact, such
complexity is unavoidable as a company expands and grows in terms of scope and business.
Some critics are however of the opinion, that such a disaster could have prevented. A careful
analysis of the financial statements of Lehman Brothers would reveal the misleading facts and
figures in the financial statements (Adu Gyamfi 2016). The statement containing cash flows that
would have highlighted the inability of the company to convert its results into cash had been
strategically ignored by the top management.
In conclusion, it can be said that the Lehman Brothers Holdings Inc. which had been
founded in the year 1850 came crashing down in 2008 owing to a number of factors. The above
essay highlights the role of the US housing market, the nonchalance on the part of the
company’s auditors and executives, the greedy traders on Wall Street, the inability of
Americans to invest in real estate and the miscalculation on the part of the Federal Reserve
in the collapse of the mogul (Chevapatrakul and Tee 2014). It is unfortunate that the auditors
and top management were solely focused on short term gains and failed to account for the
warning signs that were right in front of them. Having examined what exactly went wrong at the

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company, it is suffice to say that the top management of the company was majorly at fault for the
collapse. Faulty leadership and failure to take into account warnings signs are what led the
company to its failure (Hurley and Hurley 2015). By the end, the company had lost the faith and
goodwill of its investors, creditors, the government and even its client. As a result, not a single
hand came to rescue the company while it was drowning. The collapse of the Lehman Brothers
was one of the largest in the history of financial organizations around the world – an incident
whose repercussions were felt for years after it happened.

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Adu-Gyamfi, M., 2016. The Bankruptcy of Lehman Brothers: Causes, Effects and Lessons
Learnt. Journal of Insurance and Financial Management, 1(4).
Ball, L., 2016. The Fed and Lehman Brothers: Introduction and Summary (No. w22410).
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Chevapatrakul, T. and Tee, K.H., 2014. The effects of news events on market contagion:
evidence from the 2007–2009 financial crisis. Research in International Business and
Finance, 32, pp.83-105.
Cline, W.R. and Gagnon, J.E., 2013. Lehman died, Bagehot lives: Why did the Fed and Treasury
let a major Wall Street bank fail?. Peterson Institute for International Economics, no PB13-21.
Del Giovane, P., Nobili, A. and Signoretti, F., 2013. Supply tightening or lack of demand? An
analysis of credit developments during the Lehman Brothers and the sovereign debt crises.
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Duygan‐Bump, B., Parkinson, P., Rosengren, E., Suarez, G.A. and Willen, P., 2013. How
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